Estimating the size of corruption in India

Everybody knows corruption is rife in India. Just how bad is the problem? The Economist attempts to quantify corruption in India using three methods:

The first is to tally the money made from scams, based on estimates from officials and investigators. (Our calculation uses realised profits, or the present value of anticipated profits. We use the low end of some official estimates.) The second approach, which is applied more widely in our new index of cronyism (see article), measures the relative performance of billionaires in industries, such as mining and property, that are prone to rent-seeking relative to those in other lines of business (see chart 1). A final method tracks the relative performance of an index of politically linked listed firms constructed by Saurabh Mukherjea of Ambit Capital, a broker (see chart 2). An average of the approaches suggests the gains from rent-seeking over the past decade peaked at about $80 billion. That is equivalent to 7% of the stockmarket’s value today. It is worth noting, though, that the share of GDP for the rent-seeking billionaires and the premium on politically connected firms are no longer what they were in the boom years.

Assuming bribes paid were 5-15% of money made by businessmen, the Economist estimates that total bribes paid would amount to $4-$12bn.  Presumably, this is over a decade. Translating into rupees, this amounts to Rs2400-7200 crore every year.

What ails democracy?

The Economist has an interesting essay on the subject. Democracy was widening until the turn of the last century. For the last eight years, it has declined, going by the number of people living in democracies. The declines have taken place outside the West. In the West itself, the effectiveness of democracy as a creator of prosperity is coming under a cloud. Why so? The Economist identifies what it believes are the two primary causes:

THE two main reasons are the financial crisis of 2007-08 and the rise of China. The damage the crisis did was psychological as well as financial. It revealed fundamental weaknesses in the West’s political systems, undermining the self-confidence that had been one of their great assets. Governments had steadily extended entitlements over decades, allowing dangerous levels of debt to develop, and politicians came to believe that they had abolished boom-bust cycles and tamed risk. Many people became disillusioned with the workings of their political systems—particularly when governments bailed out bankers with taxpayers’ money and then stood by impotently as financiers continued to pay themselves huge bonuses. The crisis turned the Washington consensus into a term of reproach across the emerging world.
Meanwhile, the Chinese Communist Party has broken the democratic world’s monopoly on economic progress. Larry Summers, of Harvard University, observes that when America was growing fastest, it doubled living standards roughly every 30 years. China has been doubling living standards roughly every decade for the past 30 years. The Chinese elite argue that their model—tight control by the Communist Party, coupled with a relentless effort to recruit talented people into its upper ranks—is more efficient than democracy and less susceptible to gridlock.

Setbacks to the cause of democracy include Russia under Putin, the Iraq war (which led many to believe that democracy was a fig-leaf for the spread of American imperialism) and the turn of events in Egypt where we are back to army rule. Political gridlock in the US and the stagnation in the Eurozone have done little good for the democratic ideal. Independent economic policy is becoming difficult to implement in a globalised world and this makes voters angry. In the West, voters are reluctant to stomach austerity in the medium-term as an answer to their current problems.

The Economist's solutions are not particularly inspiring. It wants to curb the growth of the state, which may be the right answer in the West but not necessarily the right one in developing countries. In the latter, the problem is not that the state is too large but that it has not got the mix of activities right. A more efficient state, not a smaller one, is what a country like India needs. Another solution is to insulate policies from short-term populist pressures by handing over decisions to technocrats and independent commissions. This assumes that technocrats will work for the larger good and can be held accountable if they fail to do so. In a country like India with weak institutions, it is better to have incompetent politicians who are accountable that very competent technocrats who are not.

The Economist glosses over the subversion of democracy by money power or crony capitalism, which has done a great deal to discredit democracy. To succeed in politics, you need big money and the providers of big money have to be taken care of by successful politicians. No democracy has been able to tackle this scourge. Another big problem is the lack of accountability of politicians in the interregnum between elections. We can kick out the party in power once in five years but how do voters express their ire towards politicians or policies during that period? These issues, to my mind, are most important than the ones the Economist raises- and so is the need to find answers to them.

Urjit Patel report on monetary policy

There has been a fair bit of controversy over the Urjit Patel committee report on monetary policy. The idea of inflation targeting, in particular, has drawn flat. DM Nachane, member PM's council of economic advisors, has a very good critique in EPW.

First, Nachane questions the assumption that there is no long-run trade-off between inflation and output, which is another way of saying that the Phillips curve holds only for the short-run. This, he says, has been "empirically rejected" in recent research.

More importantly, he believes that inflation targeting won't work for the following reasons:

i. It means letting go the nominal exchange rate- and that's hard to do, given the havoc that can be wrought by sharp movements in the exchange rate. (eg if the exchange rate is appreciating, you may need to lower the interest rate but you can't do that if inflation is above your target).

ii. It's hard to practise as long as the fisc is out of control.

iii. Inflation targeting does not mean asset price stability and hence financial stability- this is the great lesson from the sub-prime crisis.

One might add a point that has been made by others in the debate: when inflation is largely supply-driven and, that too, food-driven, targeting it through demand side policies will cripple growth without making a dent on inflation. The really solid case for inflation to be kept within a limit would be that otherwise we could have prolonged currency depreciation and this would undermine confidence of foreign investors. But it is not necessary that the currency should depreciate if there is an improvement in productivity. 

Nachane also makes weighty arguments against the use of the CPI instead of the WPI for measuring inflation. One is that the CPI is more representative of the consumption of the better off because consumption is weighted by each household's expenditure- what he calls a 'plutocratic bias'.

Incidentally, the problems with inflation targeting don't go away if parliament sets the inflation target, a solution that has been mentioned in the debate. Inflation targeting is not desirable in the present Indian context. Period.

Maruti's Gujarat plant: a test case for corporate governance

The controversy at Maruti seems to be hotting up with news that independent directors on the board- or at least some of them- have raised the flag of revolt. The issue is the decision on the part of Maruti's parent, Suzuki, that it will invest in a car factory on land provided in Gujarat and not Maruti, which will be used more a sales arm for the products of the Gujarat plant.

Institutional shareholders- mutual funds and insurance companies- have protested, saying that the decision on the part of Suzuki is against the interests of minority shareholders. One critical issue is of transfer pricing of cars between the proposed Suzuki plant in Gujarat and Maruti. There are apprehensions that the transfer price can be managed in ways that suit the parent and work to the detriment of Maruti shareholders.

Now, independent directors have been stirred to protest. If they do take an uncompromising stand- and if some of them resign if Maruti and Suzuki stick to the decision on the Gujarat plant- we can say that we have finally a fundamental shift in corporate governance in India. Maruti is thus an important test case- and its resolution will be worth watching now that Sebi has reportedly taken up the matter suo moto.

ET reports:

Highly-placed sources said that the majority of independent directors on Maruti's board have opposed the decision. The independent directors are corporate lawyer Pallavi Shroff, former Ranbaxy chief executive D S Brar, NHAI chairman R P Singh and ex-PwC head Amal Ganguli. Suzuki chairman Osamu Suzuki, instrumental in pushing the deal, is also a member of the Maruti board.

The sources said the minutes of the last board meeting, where the surprise decision on the Gujarat plant was taken, will be discussed when the directors meet on March 15. The protests by shareholders and directors is bound to crop up given that the issue has now reached the market regulator Sebi.

While describing the latest event as "a repeat of 2004" when Suzuki Powertrain (majority owned by Suzuki) was formed for making diesel engines, some of the independent directors want Suzuki to clearly state that Maruti will not be asked to fund the Gujarat project later. In any case, there are fears that Maruti, which commands nearly 50% market share, will turn from a leading carmaker into a "trading concern".

Maruti management, however, insists that the deal remains profitable for the company and investors. "It is a win-win proposition and we are not re-considering it," Ayukawa told TOI, in perhaps the first reaction from the Japanese MD after the investors went public with their dissent. 

The Gujarat plant is not the only contentious issue involving Suzuki and Maruti's minority shareholders. The royalty that Maruti pays to Suzuki is also an issue. On this TN Ninan of BS has some scathing observations to make:

Consider the royalty question. Suzuki charges 5.7 per cent of Maruti sales as royalties (nearly double the level that prevailed before the government abolished caps on such payments in 2009). This is an astonishing 40 per cent of pre-royalty profits, and the company is far and away the top remitter of such royalty payments. What makes the payment particularly egregious is that cars are not like pharmaceuticals - between a half and two-thirds of the final product value comprises bought-out items like tyres, ball bearings, wheels, batteries, seats, headlights and gear assemblies. To claim royalty payments on their value, to which Suzuki has contributed nothing by way of technology, is rich. The royalty outgo, if calculated on the car value that is not bought-out, works out to 15 per cent or more. This is extortionate; the company's defence, that Maruti nevertheless offers good profits, is not an answer. Ambit Capital, which has looked at international companies in India, ranks Maruti as the worst for how it treats its Indian shareholders. 

There are conflicts of interest between the majority and minority shareholders at PSUs and Indian industrial houses. The revelation in recent years is that MNCs are not exactly exemplars of governance when it comes to treatment of minority shareholders.

Job creation should focus on rural sector, not manufacturing

Most economists writing about India have a standard prescription for job creation: unleash private manufacturing by changing labour laws, reducing approvals and getting rid of inspector raj. The comparison made is with China, which was able to generate a large number of jobs in light manufacturing. As long as manufacturing's potential is suppressed, the argument goes, there isn't much hope on the employment front.

Rajiv Lall, writing in BS, has a refreshingly different point of view. India's planners want to raise the share of manufacturing employment in the labour force from 11 to 22 per cent over the next 15 years. Lall thinks this is a trifle too ambitious because the corresponding share in China today is just 12 per cent, and even at its peak was only 15 per cent. India missed the light manufacturing bus over the past couple of decades and is unlikely to catch it because technology is changing the future of light manufacturing:

However, technological developments in the field of digitisation, robotics and 3-D printing are going to have profound implications for the future of low-cost manufacturing around the world. Such technologies are replacing low-skill labour and making it possible, to cite just one example, for toy makers in California to profitably relocate their manufacturing operations from Asia back to the US. The same is likely to happen to consumer electronics. So if we are imagining that we will be able to replicate the experience of the Asian Tigers in generating jobs and raising incomes by focusing on low-cost manufacturing, we need to think again.

So, solutions to boost employment through manufacturing are unlikely to yield much. What should we do? Lall sees useful pointers in where jobs have come from in recent years. The share of agriculture in employment dropped by eight percentage points in 2000-2010. Of this eight per cent, nearly two thirds were absorbed in the rural, not urban, sector. Where did they go? Into construction and services in the rural areas. "So, in fact, it is the rural non-farm, non-manufacturing sector that has emerged as the largest job creator in India - it has added as many as 35 million jobs since 2000."


The rural, non-farm, non-manufacturing sector, is, therefore, where the focus on job creation must be in the coming years:

Employment opportunities are, therefore, likely to grow fastest in the rural non-farm sector, which has undoubtedly contributed to the impressive fall in rural poverty that we have seen over the past decade. This poorly understood segment of our economy needs to be empowered to allow millions of self-employed and casual workers to take advantage of the spillover effects of rising urban and farm incomes in order to find more stable and gainful employment opportunities in the future. 

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What is the best way to give food subsidies?

There are three ways in which subsidies can be given: food handouts, cash, vouchers. Which is most effective is an important policy issue. The Economist summarises the results of a recent paper on the subject, which analysed an experiment carried out by the World Food Program in Ecuador in 2011:

The study found that direct handouts—Iran’s new policy—were the least effective option. They cost three times as much as vouchers to boost calorie intake by 15%, and were four times as costly as a way of increasing dietary diversity and quality (see chart). Distribution costs were high, and wastage was also a problem. Only 63% of the food given away was actually eaten, whereas 83% of the cash was spent on food and 99% of the vouchers were exchanged as intended. Food transfers have also been the costliest option in similar projects in Yemen, Uganda and Niger, according to John Hoddinott at IFPRI.

In Ecuador there was little difference in cost between handing out cash and food vouchers, the other two options. But vouchers were better at encouraging people to buy healthier foods because of restrictions on what items could be exchanged for them. It was 25% cheaper to boost the quality of household nutrition using food vouchers than it was by handing out cash. A switch from universal subsidies to vouchers could be the most efficient way of boosting health as well as relieving poverty.

So, the order of preference, according to the study, should be: vouchers, cash, handouts. However, it would be unwise to generalise from the results of an experiment in a small country such as Ecuador. It is easier to hand out vouchers to a small population. Moreover, access to food can be ensured. In a large country, such as India, how do we ensure that, in the absence of public distribution outlets, there are places where people with vouchers or cash can go to in order to exchange these for food? Moreover, we need a certain stability in food prices. Vouchers or cash may not fetch enough food if they have been issued on the basis of food prices that were lower than the prices at a given point in time.

Your success is in your genes

Once in a blue moon, there comes along a book that knocks the hell out of all your preconceptions and convenient beliefs. Gregory Clark's book, The son also rises: surnames and the history of social mobility must fall in this bracket. I haven't had a chance to read the book myself but I have seen many the reviews (including the ones in the Economist and the Guardian), an interview with Clark and several comments on the Net. Clark's own brief exposition on his book is here.

Clark's thesis is that how successful you are in life can be traced to your ancestors 15-20 generations ago, or nearly 300 -450 years ago. This means the way society is constructed today reflects the distribution of haves and have-not in the nineteenth century or so. Here's a stunning precis of his thesis:

According to his calculations, if you live in England and share a last name with a Norman conqueror listed in the Domesday book of 1086—think Sinclair, Percy, Beauchamp—you have a 25 percent higher chance of matriculating at Oxford or Cambridge. If you’re an American with an ancestor who graduated from an Ivy League college between 1650 and 1850, it’s twice as likely that you’re listed in the American Medical Association’s Directory of Physicians.

True only of elitist societies such as the US or the UK? Not by a long chalk, says Clark. He has looked at Scandinavian countries and found that social mobility hasn't changed much. Most astonishing is his study of China. Despite the cultural revolution, despite the annihilation of large numbers of those in the elite, Chinese society is dominated by the descendants of those who were at the top before the Maoist revolution. As Clark puts it:

When you look across centuries, and at social status broadly measured — not just income and wealth, but also occupation, education and longevity — social mobility is much slower than many of us believe, or want to believe. This is true in Sweden, a social welfare state; England, where industrial capitalism was born; the United States, one of the most heterogeneous societies in history; and India, a fairly new democracy hobbled by the legacy of caste. Capitalism has not led to pervasive, rapid mobility. Nor have democratization, mass public education, the decline of nepotism, redistributive taxation, the emancipation of women, or even, as in China, socialist revolution.

The exasperating thing about Clark's findings, one that will raise hackles amongst do-gooders, is that there isn't much you can do to improve social mobility. If you had great ancestors, you have everything laid out for you; if you are ancestors did not amount to much, chances are you won't either. The best of educational opportunities, the most open and meritocratic selection processes will not make much of a difference to outcomes. To quote Clark again:

If your surname is rare, and someone with that surname attended Oxford or Cambridge around 1800, your odds of being enrolled at those universities are nearly four times greater than the average person. This slowness of mobility has persisted despite a vast expansion in public financing for secondary and university education, and the adoption of much more open and meritocratic admissions at both schools.

Clark's conclusion is grim and unsettling:

Large-scale, rapid social mobility is impossible to legislate. What governments can do is ameliorate the effects of life’s inherent unfairness. Where we will fall within the social spectrum is largely fated at birth. Given that fact, we have to decide how much reward, or punishment, should be attached to what is ultimately fickle and arbitrary, the lottery of your lineage.

What do these findings mean for public policy? Should governments thrown up their hands and just allow genetics to play out? Not at all. Quite the contrary, perhaps. Since inequality will not be rectified in the natural course- and certainly not by providing adequate economic or educational opportunity- there is an even stronger case for affirmative action or quotas to redress inequalities in society. By the same token, since the gifted will naturally rise to the top, the case for large incentives to reward the successful is undermined.

In India, the argument that we should open primary and higher secondary education through scholarships and generous funding in order to help who have lagged behind traditionally would not wash, going by Clark's findings. If we believe that inequality is unacceptable beyond a point and that social inequities threaten peace and order in society, the case for affirmative action is even stronger than before. It is only through aggressive quotas in jobs as well as higher education that we can give a leg-up to the under-privileged.

We Indians can, perhaps, legitimately tell Clark: we knew this all along; here we say 'sab sar pe likha hai'.

How do B-schools respond to the MOOC challenge?

B-schools have yet to figure  out how to address the MOOC challenge. It is easy to shrug it off, saying that online is no substitute for class-room interaction. That may be well the case but we need to ask: what price level are we talking about? B-schools are investing hugely in expensive infrastructure and charging higher and higher fees. It's not clear that the pay-offs to a B-school degree are rising commensurately. Perhaps, for the top schools, yest. Not for the rest. That's why GMAT- and CAT- applications are falling.

How do b-schools respond? Schumpeter harks back to the Porter model: you compete on cost or quality. For the top schools, the answer may be the latter- offer such a high quality program that it pays off. For the rest, however, costs cannot be ignored. Schumpeter points out how some B-schools are responding;

Though the average fee for an American MBA course has risen by a third over the past four years some schools, such as Cornell and Rochester, are offering shorter courses and others, including Maryland and UCLA, are forgoing the annual fee increase. Ashridge, near London, focuses on short courses for executives. But too many continue to stick their heads in the sand. Meanwhile, they face competition from companies with a monetary incentive to control costs and expand enrolment. The Career Education Corporation, an American firm, is assembling a portfolio of business-oriented institutions. Laureate Education has over 800,000 business students in 30 countries. Private schools such as these are directly challenging the faculty-dominated not-for-profit model, employing staff to teach rather than research and making it easier to combine study with work. And some consultancies and investment banks are running in-house mini-MBAs.

As Schumpeter points out, pruning costs and offer a low-cost model is not easy for B-school administrators because they are run by academics, for academics. Most of the costs are on account of salaries and salaries are inflated to attract research talent. Who will bell the cat is a big issue for B-schools.

Navy accidents: don't just blame the neta

Admiral D K Joshi's principled resignation from the navy has evoked much praise- and rightly, for such resignations seem to belong to a different era altogether. His resignation brought in its wake a demand for the defence minister's resignation. Watching the TV channels and listening to the retired military personnel, you might have been forgiven for supposing that a professional had to pay the price for incompetence on the part of a minister or ministry. The defence ministry had been holding up modernisation of the navy's aged fleet, so it's pointless to blame the navy for the rising incidence of accidents- so we were told.

It was refreshing, therefore, to come across a balanced perspective from BS's defence analyst, Ajai Shukla (himself a former army man, by the way);

True, Mr Antony has much to answer for in how he has run his ministry, and good reasons exist separately for demanding his head. But the navy alone is responsible for a safety culture so poor that 10 warships and submarines have suffered mishaps since last August, when another submarine, INS Sindhurakshak, had a catastrophic explosion that killed all 18 sailors on board. Three out of India's 10 Russian Kilo-class submarines have suffered mishaps, while two out of six state-of-the-art Russian stealth frigates have had collisions. These are alarming figures.
It is fallacious to argue, as some have done, that India's Kilo-class submarines are inadequate or obsolete. Some 50 Kilo-class submarines serve in navies worldwide, including those of Russia, China, Vietnam, Algeria, Poland, Romania and Iran. Algeria's are older than India's, but have suffered no mishaps. INS Sindhurakshak, which sank last August, had been in service for just 16 years, and had recently returned from a mid-life refit in Russia that made it good for at least another 15 to 20 years. A service life of 30 to 40 years is quite normal for submarines. Our Foxtrot-class submarines performed yeoman service for over 35 years. The US Navy's Los Angeles class attack submarines, the mainstay of its underwater force, are 30 to 35 years old. It is plain wrong to argue, as some have done, that India's Kilo-class submarines have outlived their utility; the navy itself envisages many more years of service for these potent fighting platforms. To retire the Kilo-class submarines would be to strike a hammer blow to the navy's Maritime Capability Perspective Plan, which lays out the future fleet. India simply cannot afford that.

Admiral D K Joshi knows this, which is why he resigned.

We are right in demanding accountability in all walks of life, including politics. In the armed forces, this is especially needed because the lives of soldiers are at stake. Politicians are not the only fallible beings on this planet, so are professionals. If professionals set high standards of conduct- as Admiral Joshi has done- politicians may soon have to follow suit.